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Buying bargain dividend stocks: How I do it

I have always been a value and income orientated investor and looking for bargain dividend stocks. The majority of my portfolio is testament to that. I have experience of seeking out and buying bargain dividend stocks. Although this style of investing is out of fashion at the moment, as shown by the prices of some funds and share prices, it can still be a very profitable form of investing. Especially for the long term, because dividends compound.

Or put another way, the dividends grow year on year, allowing you the investor to buy more and more shares. As a result, you gain more and more dividend income.

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Finding value in your bargain dividend stocks

In March, finding bargain dividend stocks was easy. Many shares were trading at a discount and on a lower price-to-earnings (P/E) ratio than the 12-month average. Now with share prices and market rising again, it’s becoming a little more tricky.

It’s still possible though. One of the first things I’d look for is the P/E. This is a key indicator of the value of the shares and the lower the better, from the perspective of lowly valued shares. Typically you’d want to see a P/E below 15, as a rough guide. Along similar lines, you may want to take a look at the PEG which compares the P/E to earnings growth. With this ratio you want to see a result under 1.

Keeping an eye on yield, growth, and dividend cover

Next, you want to be looking for the dividend yield. It’s up to you how high you want this to be. Too high and the dividend may be in danger of being cut, which often leads to a sharp share price fall. And, of course, less dividend income. Too low and the share isn’t really providing much income. I typically look for share with a yield above 3.5% and ideally above 4%, but not above 8%.

The other dividend metrics to look at are dividend cover, which ideally would be above 2, but for a large company may be lower and not be problematic. I’d also want to see consistent dividend growth. With all these criteria, there are some exceptions, but generally I do want to see a low P/E and PEG as well as a decent yield along with stable dividend cover and growth.

Examples of bargain dividend stocks

DS Smith (LSE: SMDS) is an example of a bargain dividend stock. It combines a P/E of around 10 with a PEG below 1, based on historic earnings growth. It also has a dividend yield of 4.6%. Dividend cover has been falling slowly but is still above 2 and dividend growth in four of the last five years has been above 12%. Overall, I think it may be one of the best examples of a bargain dividend stocks in the FTSE 100. Although there are many others

This is how I find bargain dividend stocks and I hope it helps you. Investing in dividend-paying shares, for many years, is I believe a winning strategy for any serious investor. 

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Andy Ross owns shares in DS Smith. The Motley Fool UK has recommended DS Smith. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.